What is a pension?

In a nutshell: what is a pension?

To see how much you’ll need to be saving for retirement, use our pension calculator:
https://www.nutsaboutmoney.com/pensio...

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Learn more about pensions:
https://www.nutsaboutmoney.com/pensions

The current State Pension is £221.20 per week, or £11,502 per year.

A pension is a pot of money that you’ll live on in retirement, to help you pay the bills, and ideally live a comfortable life, without any money worries.

Retirement can be any age that you want to stop working, provided you have enough money to do so, but typically in the UK, most people retire around the State Pension age, which is between 66 and 68, depending on what age you are now.

That’s because most people will get the State Pension, which is the pension from the government, and which you’ll get if you’ve paid enough National Insurance contributions over your working career. You need at least 10 years, but 35 years worth of payments to get the full amount.

However, the State Pension isn’t a lot of money. You’ll likely struggle to live off this alone, and it’s much less than the recommended minimum amount for a retirement income.

That’s where a private pension comes in, and this is a pot of money that’s in your name, so private to you, rather than the government. It's kind of like a savings account.

Here’s where things get a bit confusing, but stick with me.

There’s two main types of private pensions, a workplace pension and a personal pension.

A workplace pension is a pension from work, and you’ll pay into it from your salary each month, before you pay tax, so your contributions are tax-free, and this builds up over time, with your money typically invested by experts who will grow your money much more over time.

If you work in a public sector job such as the NHS, when you retire, you’ll typically get a set amount of money each month for the rest of your life, depending on how long you’ve worked there and what your salary was. This is called a defined benefit pension.

Whereas typically in private sector jobs, such as working for a company, your money goes into a pension pot that’s set up by your employer, but is all yours, and has a value such as £200,000. You’ll use this pot to provide you with a retirement income when you retire. Your employer should also contribute at least 3% of your salary, if you contribute 5%.

These pensions are called defined contribution pensions, and you can transfer the pension pot to a provider of your choice when you change jobs. This is recommended so that you don't have lots of pensions from lots of different jobs all over the place. It makes it easier to manage.

The other main type of pension is a personal pension, and these are similar to pensions through work in private sector jobs, and are a great addition to a pension from work to boost your total pension pot, or your only option if you’re self-employed.

You choose what pension provider to use, and can decide how much to save, whenever you like, for instance monthly.

All the money you save into your personal pension will be tax-free too, just like a pension from work, but as you’ve already paid tax your money, for instance tax on your salary, the government will automatically give the tax back to you as a 25% bonus on the money you save into it, and if you pay 40% or 45% tax, you can claim this extra back at the end of the tax year by filling out a Self Assessment tax return.

In total, every year across all of your pensions, you can save up to your annual income, or £60,000, whichever is lower.

With defined contribution pensions, so personal pensions you set up and pensions with standard private companies, you can start withdrawing your money from age 55, although this is rising to 57 soon.

And 25% will be completely tax-free, which you can take as a lump sum if you want to. With the remaining 75%, you’ll likely pay income tax, which is the same as your job, on what you withdraw, but it all depends on your total income and the income tax rules at the time.

The bad news is you’ll need a very large private pension in addition to the State Pension to provide you with a comfortable retirement. For instance, if you’re around 40 now, you’ll need a pension pot worth hundreds of thousands of pounds. Check our pension calculator (above) to get a personalised view of how much you might need, and how much to save per month.